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Firm is a coalition of interest groups- it seeks 2 balance their different objectives
Firm exists to maximize the wealth of its owners (=max present value of profits/life of the firm)
Rationale for assuming profit maximization is primary goal of a firm
- 1) board of directors legally obliged to pursue share-holder interest.
- 2) to replace assets firm must earn return on capital > cost of capital
- 3) Firms that do not maximise stock-market value will be acquired
- 1) Normal return to capital, rewards investors 4 use of their capital
- 2) Economic profit which is the pure surplus available after all inputs have been paid 4
(net profit after tax-cost of capital employed)* WACC
Advantages of Economic profit over Accounting
- 1) Sets more demanding performance discipline 4 managers
- 2) improves allocation of capital between different businesses of a firm by taking into a/c the real costs of more capital intensive businesses
Value maximising approach to strategic decision:
- Identify alternative courses of action.
- Estimate cash flows associated with each action
- Estimate cost of capital for each action
- Select the course or action which generates highest NPV.
Problems with Value maximising approach to strategic decision:
- Estimating cash flows beyond 2-3yrs is difficult
- Value of a firm depends on option value as well as DCF value.
Putting performance Analysis into practice->
- 1) Appraise current & past performance.
- Forward looking measures
- Backward looking measures
- 2)Diagnose Source of poor performance- Du Pont formula.
- 3) How can we set performance objectives?
- Balanced scorecard
Paradox of value
- Companies that are the most successful in creating long-term s/h vallueare typically those that:
- a) have a mission
- b) hove strong consistent ethical values